Ending "Too Big To Fail": Government Promises versus Investor Perceptions

Todd A. Gormley, Simon Johnson and Changyong Rhee
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Todd A. Gormley: Wharton School, University of Pennsylvania
Changyong Rhee: Asian Development Bank

No 314, ADB Economics Working Paper Series from Asian Development Bank

Abstract: Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of the Republic of Korea’s 1997–1999 crisis, suggests an answer: No. Despite a general “no bailout” policy during the crisis, the largest Korean corporate groups (chaebol)―facing severe financial and governance problems―could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests “too big to fail” beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.

Pages: 42 pages
Date: 2012-10-31
Note: http://www.adb.org/sites/default/files/pub/2012/economics-wp314.pdf
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Journal Article: Ending "Too Big To Fail": Government Promises Versus Investor Perceptions (2015)
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